Friday, September 21, 2007

"I want to buy a foreclosure."

I'm interested in foreclosures is something I often hear from clients, but few people really understand the process, and specifically what it means to buy a foreclosed property. It's not for the faint of heart. Though you can occasionally find a bargain, there are unique risks involved with buying a foreclosed or bank-owned property. First, let's clarify some definitions.

It's possible that someone can be "upside down" on their mortgage (that is, they owe more on the mortgage than the property is worth) and antsy for a quick sale before it gets worse. In this situation, the seller is said to be "bringing money to the table" because they literally need to write a check to the settlement company even AFTER receiving the proceeds from the buyer. The seller hires an agent (in most cases) and the property is listed in the MLS--the buyer may or may not even be aware that the seller is in this situation. But what if the seller doesn't HAVE funds to bring to the table? Then it becomes a...

Pre-foreclosure or "short sale": The bank is a third party to this transaction because they have negotiated with the seller to take a loss on their loan. The property will likely be listed in the MLS, but there are special addendums and disclosures because the bank has to approve any contracts. In some cases, this delays the process, which can make timing for a settlement and move date tricky. Read more about short sales in my previous blog entry here. If no buyer is found, then the property becomes a...

"Foreclosure" or trustee sale: This is the proverbial auction on the courthouse steps. Properties are advertised in the newspaper, but typically no real estate agents are involved (because there are no commissions paid--can't blame us for staying away from those!) Note that the property may or may not be vacant at this point...a buyer may be forced to evict the previous owner. This isn't typically the auctions you'd think with bidders standing around with placards. The bank is unlikely to take a bid less than what is due on the loan, and if there's no equity in the property, why would someone buy it? So you need a property that's worth more than the loan, and if that was the case then it wouldn't be a foreclosure to begin with! So most auctions quietly pass with no bidders. If you do wish to bid, it's typical for the bank to demand a 10% deposit at the auction, and you have 15 days to close. These properties are typically sold "as is." If it's a condo, the seller (the bank) is not required to provide you with condo or HOA docs, as in other sales. If the "auction" ends with out a winning bidder, the property moves to...

"Bank Owned" or "REO" (Real Estate Owned): The bank usually works with a Realtor to list the home in the MLS and it's advertised just like any other property. They are usually sold "as is" (no home inspections) and special addendums are required. The addendum is sure to include a penalty for any change or delay in closing--anywhere from $65 to $200/day. While the banks are quick to penalize buyers for any delays, they don't usually hold themselves to the same standards--Some banks have very quick turnaround time on offers (days) and some have very bad turnaround time (months). This uncertainty makes settlement and move-in dates are very tricky, if not impossible, to manage. I've seen buyers put in an offer and wait 3 months only to be told that theirs was not the winning offer. This is typically also not an option for anyone with a brokered loan or stated income loan, again, because the timing is so difficult to manage.

I've found that the only REO properties that are priced significantly cheaper than the market are those that are in very poor condition, and maybe not such a bargain at all. There are always exceptions, and yes, a handful of really great deals out there. But to limit yourself to "foreclosures" is cutting off some of the best deals out there! I've actually found that the best "deals" are where sellers have some equity and can actually afford to sell below market, and have the incentive due to a life change (new job, new baby, etc.) to motivate them!

So to recap: Most people who are looking for "foreclosures" are actually looking for "short sales" or "REO/Bank-Owned" properties. Both categories of sales come with unique risks--specifically:

1) timing--if you have a specific timeframe for moving, make sure you have a backup option for living space
2) financing - related to timing
3) property condition--you won't get to ask for repairs, and may not even be allowed to have a home inspection prior to buying

My advice? Look at all the listings, not just "foreclosures"--which we now know really means short-sales and REO, in your price range. You never know where you're actually going to have the most negotiating power!


Katie Wethman said...

Don't confuse the trustee sale/auction with an REO auction. Lately I've seen a few all day auctions where banks literally auction off dozens or even hundreds of properties. These are REO (bank owned properties) that were placed in the MLS (stage 3 above) and then didn't sell, so were removed from the market for this type of event.

Unknown said...

In recent years people have used lots of "interest only" mortgages and ARM (Adjustable Rate Mortgages) to get into houses they couldn't afford otherwise. The current foreclosure rate nationwide is .43% which is higher than last year and expected to rise again this year as the ARM's become due.

Katie Wethman said...


Keep in mind though that the foreclosure rate in the DC area is much lower than many parts of the country, and in the DC area there is a wide difference in foreclosure rates between close in area and exurbs. I believe we'll see more to come in Loudoun, Stafford, Pr William and similar areas, but there is no foreclosure crises in most of DC, Arlington or Alexandria.